Why the Prescription Drug Market Doesn’t Work for Patients

Power corrupts, and regulatory power is no exception.

What does it take to get vital medical care in America? For Laura Matson, a type-1 diabetic, it took upending her whole life. To pay for her insulin treatments, she had to sell her car and furniture, relocate, and even give away her dog Nicky, as the BBC reported. And she is not alone. Many Americans struggle to make ends meet as their health care costs rise.

These rising costs are strange, in a sense. The prices of other consumer goods—nutritious food, digital devices, clothing, etc.—generally fall as technology advances and production becomes more efficient. Why is health care such an exception to this rule?

After all, most of the medications Americans take are made of relatively simple ingredients. And once treatments are established, drugs cost very little to produce. Insulin itself is a century-old technology. So why are Ms. Matson’s insulin treatments so expensive?

Senator Elizabeth Warren blames corruption. At a recent Democratic debate, Warren said:



To an extent, Warren is right: corruption is the problem. The pharma-to-patient pipeline is clogged with it. What she leaves out is the key role that government regulation plays in that corruption.

How Regulation Makes Health Care More Expensive

Regulation in the health care industry drives up prices for patients in many ways.

The Food and Drug Administration’s approval system requires billions of dollars and nearly a decade to navigate. This strangles supply by hampering production and constrains competition by preventing smaller companies from entering the market. And as Econ 101 informs us, lower supply and less competition mean higher prices.

Federal patent policy also restricts supply and competition, especially by blocking generics. For example, as one of us wrote earlier this year in “A Government Guide to Keeping Insulin Unaffordable: 3 Easy Steps to Hogtie a Market”:

Even though insulin treatment itself can’t be patented, improvements in delivery mechanisms can be. These incremental improvements, no matter how small, can be used to extend the 20-year patent on a drug, a process called “patent evergreening.” Sanofi has filed 74 patent applications on its long-acting insulin Lantus—nearly all of them after the drug was on the market—and boxed out generics for decades. Drug makers seek extensions to their exclusivity when they add pill coatings and alter inactive ingredients, extending their monopoly but offering no marginal advantage to patients.

Cheaper drugs of comparable quality produced abroad are simply illegal to import or resell in the U.S.

At every stage where regulation narrows the choices available, patients lose. Life-saving treatments become harder to access and more expensive.

To return to Laura Matson, regulation drove up the cost of her insulin treatments by limiting competitive market innovation at every opportunity. A generic version of a drug or insulin injector pump can drop the price by up to 90 percent, but the government blocks generics. Nearly identical, perfectly safe insulin products can be bought from Canadian drug makers, but imports are illegal. Heavily regulated insurance issuers are legally limited to a handful in each state, and each plan reimburses only some brands.

Pharmacies could dispense treatments popular in the 1990s for pennies, instead of the expensive, cutting-edge tech. Ms. Matson might have been willing to test her blood sugar more than once a day with tedious strips or deal with the hassle of vials and needles if it meant she could keep her apartment and her beloved dog. But regulations deny her that choice.

Patients Lose—So Who Wins?

If you want to understand any regulatory scheme, ask yourself, who benefits from it? Policymakers may have pitched the rules as protections for patients—indeed that may have been the sincere intention of some. But clearly, the system does not benefit Ms. Matson or others like her. When a dirt-cheap, exceptionally common prescription like insulin keeps getting more costly while everything less regulated becomes less expensive, the regulations are standing in the way of progress.

So if not patients, who benefits?

The executives and shareholders of big, established pharmaceutical companies certainly do. They hold the valuable patents that prevent generics competitors from underselling them. And FDA compliance costs may hurt their bottom line, but they are big enough to absorb them, while smaller would-be competitors are not. So regulation creates a barrier to entry—a “you must be this big to ride” bar—that keeps out upstart competitors.

A revolving door between regulatory agencies and the companies they’re regulating creates pressure to be “good for (big) business.”

By stifling competition in the above ways, regulation can protect the market share of the big boys, granting them inflated, cushy profit margins, at the expense of patients, who pay inflated, onerous prices for care.

Of course, FDA bureaucrats benefit, too: a lengthy approval process provides them highly paid jobs. And for many of them, the gravy train doesn’t stop there. Big pharmaceutical companies often hire former regulators at very generous salaries to help navigate the FDA gauntlet.

Scott Gottlieb was FDA commissioner until just months ago and is now on Pfizer Inc.’s Board of Directors. Current Secretary of Health and Human Services Alex Azar is a former Eli Lilly executive.

A revolving door between regulatory agencies and the companies they’re regulating creates pressure to be “good for (big) business.” Doing little favors for one another (downplaying an unfavorable trial, tying a competitor up in some extra red tape, delaying the approval of a generic alternative) overrides public interest as former and future colleagues play a slow, highly profitable game of musical chairs.

The Problem of Regulatory Capture

When regulatory agencies are thus “captured” by big players in the industries they regulate, it is called “regulatory capture.” Regulatory capture runs rampant in highly regulated industries, and it is not too hard to understand why.

But in the regulated-market “cripple your competitor” game, the Goliaths have an extra advantage.

In a free market, the way to “win the game” is straightforward and fixed: serve your customers better than your competitors do. But in a highly regulated market, the rules of the game are malleable. This opens a new path to success: helping to make regulations that disadvantage your competitors.

Influencing the rules of the game then becomes a big part of the game. Instead of playing better, you can win by calling the referee and getting your opponent thrown out. So gaining sway over the rule-makers and rule-enforcers (regulators) becomes paramount, and satisfying customers less so.

The free-market “satisfy the customer” game has historically been characterized by businesses rising and falling. Time after time, incumbent Goliaths are brought down by upstart Davids. (Think of Netflix busting Blockbuster.) Out of the companies in the Fortune 500 of 1955, only 52 still ranked on that list in 2019.

But in the regulated-market “cripple your competitor” game, the Goliaths have an extra advantage. With their lobbying budgets and political connections, they are in a better position to capture their regulators and rig the rules of the game in their favor.

Regulatory Power Corrupts

So Senator Warren is right in a sense: prescription drugs are indeed expensive because of corruption. But that corruption is made possible (and irresistable) by regulation. Power corrupts, and regulatory power is no exception. This is not a problem of capitalism, but of cronyism: a symbiotic relationship between big government and big business.

The real solution to rising health care costs is less regulatory power, not more.

And Warren’s proposed solutions—further concentrating power with a Medicare for All plan, or letting government agencies oversee production of generic drugs—would only make the problem worse. Imagine the profitability of requiring only name-brand drugs through Medicare; giving regulators more power increases interest groups’ incentives to manipulate regulators instead of serving customers.

The real solution to rising health care costs is less regulatory power, not more. The great disruptors that lower prices and accelerate access—the Amazons and AirBnBs of health care—are out there, but regulation is standing in their way. As long as regulators have the power to exclude products and companies from the marketplace, some businesses will try to game the system instead of upping their game. Less rule-rigging would mean more competition, more services, and lower prices for people like Laura Matson.